Debt Consolidation Loans and Lower Interest Rates

Melinda (Milli) Haine Melinda (Milli) Haine | Loan Underwriter

Among the many reasons to consider debt consolidation loans for eliminating high-interest debt is the tendency for these loans to offer lower interest rates. Most of us know that lower interest rates generally mean good things for borrowers, but do you know why? Furthermore, do you understand that debt consolidation loans will not be as attractive as they are now once interest rates start going up?

If you're thinking about debt consolidation at any point in the near future, you might want to consider applying for a loan as soon you can. The Bank of England is already thinking about increasing the base rate, and the first increase could come shortly after the May government announces its plans for Brexit negotiations.

If you're not quite sure why applying for debt consolidation would be better than waiting, keep reading. The information below should clear things up for you.

We Owe More, But Still Less

One of the hardest things to comprehend in the arena of personal and secured loans is what is known as the 'total cost of borrowing'. We can discuss debt consolidation loans as an example.

When a consumer borrows in order to consolidate debt, he or she must repay the principal amount borrowed plus interest. But there's more. He/she must also pay fees and charges attached to the loan. The total amount the borrower pays over the life of the transaction is the total cost of borrowing.

Interest makes up the bulk of that cost, which is why we pay so much attention to interest rates. If you understand how interest works, you know that you can borrow less and still repay more if your interest rate is high enough. To illustrate this point, let's look at some numbers recently provided by The Money Charity:

  • Average interest rates in November 2016 were 2.68% (mortgage), 10.21% (credit cards) and 6.7% (other loans)
  • Rates on the same kinds of loans in April 2008 were 5.8%, 12.16%, and 8.39% respectively
  • Total consumer debt in 2016 reached £1.5 trillion; the number was closer to £990 billion in 2008.

Based on 2008 interest rates, Britons were paying roughly £86 billion in interest as compared to the £52 billion paid last year. So even though we owed more principal in 2016, we actually paid less to service that debt, which resulted in a lower total cost of borrowing. In fact, The Money Charity says that if interest rates had not changed since 2008, we would be paying 81% more to service our collective debt today.

Interest Rates and Debt Consolidation Loans

We've bored you long enough with hard numbers and financial details; let's get to the question of how this all relates to debt consolidation. Remember that the point of debt consolidation is to pay down debts with higher interest rates using the equity in your home.

Interest is compounded annually based on the amount of principal still owed. That means debts with higher interest rates apply less of the monthly payment toward reducing principal and more to paying interest. It takes longer to pay the loan, which inevitably increases the amount of interest paid along with the total cost of borrowing.

As the numbers from The Money Charity clearly demonstrate, lower interest rates reduce the total cost of borrowing over the same amount of time. That's why debt consolidation loans are such good tools. By consolidating a group of high-interest debts into a single debt with a lower interest rate, the borrower ends up with a lower total cost of borrowing.

Sources:

The Money Charity ?? http://themoneycharity.org.uk/britons-owe-pay-less-interest-will-last/

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